No Dr. Krugman, Government Debt Matters Because It's Ours

When Nobel laureate Paul Krugman began a recent New York Times column by showing concern about “disastrously high unemployment,” we could sympathize with his assertion that too much attention is focused on “the allegedly urgent issue of reducing the budget deficit.” After all, there are many other factors that prevent us from employing our resources in the most productive uses. We are overregulated, overtaxed, overinflated, and the government spends wastefully and too much.

If we were to prioritize any of those policies, such as cutting tax rates, then we could justify tolerating high deficits a little longer. The brighter prospects for higher growth and improved resource employment would increase our future debt-service capacity.

But this is not what Professor Krugman is talking about. He believes that we need more government spending, not less. Drawing inspiration from John Maynard Keynes, he remarks that Keynes wrote about the need to spend our way out of the depression when “Britain was deeper in debt than any advanced nation today, with the exception of Japan.”

Krugman supports his argument by noting that Britain “has had debt exceeding 100 percent of GDP for 81 of the last 170 years.” We could be forgiven for rather doubting that this supports his argument.

The root of Krugman's confusion on debt lies in adherence to what my old professor James M. Buchanan (also a Nobel laureate) once called the New Orthodoxy. Krugman believes that governments differ from families in that they don't have to pay back their debt. From this, he can deny that debt burden is shifted on to future generations. Krugman also believes that when Americans lend to the U.S. government there is very little burden because “we owe it to ourselves.”

Acceptance of the New Orthodoxy was a boon to big-spending politicians and their special-interest groups. If government debt was less burdensome than once believed, then they could justify the greater use of debt to fund government spending.

Professor Buchanan's great contribution (54 years ago) was to show that the New Orthodoxy was wrong. Government debt really does resemble private debt. Government debt really does shift the burden onto future generations. Also, the distinction between internal and external debt is largely false.

Krugman's debt theory fails for the same reason that his government-spending stimulus theory fails. He sees us in the aggregate, not as individuals. This is why he can claim that “every dollar's worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners” as if it all just nets out. What he does not mention is that each of us is affected differently.

When someone buys a government bond, it is a voluntary market transaction. The buyer voluntarily gives up current resources for use by the government. There is no symmetry for taxpayers, especially those in future generations. For those who bear the burden of current and future taxation, the transaction is not voluntary.

It makes no sense to say that “we owe it to ourselves.” Even when Americans lend to the U.S. government, those who lend are not necessarily the same as those who bear the burden. Understood this way, Krugman would be correct to downplay the extent to which we are “in hock to the Chinese.” But he is wrong to downplay the extent to which we are in hock.